Latest Stories

What's your fraud IQ?

Fraud is not an accounting problem or an internal control problem; it
is a human problem. Not even the strongest system of controls can
eliminate all risk of organizations’ being defrauded by employees who
are sufficiently motivated to find loopholes, ways to override
controls, or opportunities for collusion. While most accountants are
familiar with methods for identifying manipulated accounting data,
effectively fighting fraud involves going further and understanding
the human elements involved. Such knowledge can help CPAs design or
assess internal control initiatives, recognize fraud red flags during
professional engagements, and identify where organizations are most at
risk. Take this quiz to see whether your knowledge of fraudsters’
mindsets, characteristics, and behaviors is sufficiently honed to help
you recognize the warning signs of fraud.

1. Research has shown that the most common reason
that CFOs commit financial statement fraud is:

a. To cover up embezzlement or other fraud schemes.

b. Pressure from CEOs.

c. To increase the value of their own investments in company stock.

d. To hide their own errors or poor judgments that led to weak
financial performance.

2. Melissa, a full-time retail store manager, is
pursuing a college degree. Because of her work demands, she limits her
school schedule to two night courses per semester. At this rate, she
anticipates it will take her seven years to graduate. While closing
the store one night during a shift that caused her to miss one of her
classes, Melissa grew particularly frustrated with her situation. She
began a scheme that involved skimming portions of the store’s cash
sales and processing refunds to her own credit card, intending to use
the stolen funds to quit working and finish school faster. In turning
to fraud, Melissa demonstrated which of the following thought patterns
common among fraudsters?

a. Entitlement.

b. Inadequate fear of punishment.

c. Instant gratification.

d. Egoism.

3. In the 1960s, Stanley Milgram, an American social
psychologist, conducted a study to understand why millions of Germans
followed the orders of their Nazi leaders. His research produced
interesting findings about why people engage in acts that seem to
conflict with their morals, values, and ethics. Specifically,
Milgram’s experiment demonstrated which of the following?

a. Most people will follow orders from authority figures to perform
acts that conflict with their personal morals, values, and ethics.

b. The more authority an individual has, the more likely he is to
abandon his morals and engage in unethical actions.

c. People are most likely to engage in unethical actions when they
do not fear the expected punishment.

d. An individual’s propensity for engaging in unethical actions is
genetically predisposed.

4. Which of the following is true regarding the
behavioral traits and characteristics displayed by fraudsters?

a. The majority of fraudsters have a history of legal problems.

b. There are no observable patterns to the behavioral traits
displayed by fraudsters.

c. The most common behavioral red flag among fraudsters is the
tendency to live beyond their financial means.

d. Staff-level fraudsters are more likely to exhibit control issues,
such as being unwilling to allow people to review their work, than
executives who engage in fraudulent activity.

5. Which of the following individuals most fits the
statistical profile of an occupational fraudster?

a. Kathryn is a 22-year-old customer service representative. She has
been employed by the company for approximately five months. She has a
high school diploma, and her criminal record shows a misdemeanor petty
theft conviction when she was 19.

b. Charlie, a 38-year-old college graduate, works as a senior
accountant. He has been employed by the company for approximately 3.5
years and has no criminal background.

c. Patricia is 53 years old and is the company’s vice president of
marketing. She has an MBA and has been employed by the company for 25
years, having worked her way up from an entry-level marketing
position. She was charged with passing two bad checks seven years ago
but was cleared of wrongdoing, and she has an otherwise clean criminal record.

d. Davis is a 57-year-old warehouse foreman. He is a high school
dropout, and his criminal record shows two prior convictions for
assault, one of which resulted in jail time. He has been employed by
the company for almost 10 years.

6. According to research conducted by Robert Feldman,
how many times does the average person lie during a 10-minute conversation?

a. None.

b. One time.

c. Three times.

d. 10 times.

7. How often can the average person correctly
identify when someone is lying to him or her?

a. Approximately 10% of the time.

b. Approximately 50% of the time.

c. Approximately 75% of the time.

d. Approximately 95% of the time.

8. Which of the following statements is the most
accurate regarding the behavior of a deceptive person (that is, a
person trying to conceal something) during an interview?

a. When asked about hypothetical fraudulent conduct (e.g., “What do
you think should be done to someone who steals from his employer?”), a
deceptive person typically will display a disproportionately
intolerant attitude.

b. A deceptive person will generally be more willing to terminate an
interview than an honest person.

c. A deceptive person is more likely to engage in outright denials
of an event or action than an honest person.

d. A deceptive person will frequently use phrases such as “to tell
you the truth” or “honestly” to add credibility to his statements.

9. Rodrigo, CPA, is meeting with Amelia, the
accounting manager, to discuss some anomalies within the company’s
cash disbursements system. Rodrigo asks Amelia a series of general
questions about the cash disbursement process, then moves to the topic
of several checks with out-of-sequence check numbers that cleared the
company bank account. Which of the following behaviors is most likely
to be a clue that Amelia is being dishonest in her responses?

a. Amelia is sitting with her head and the trunk of her body facing
Rodrigo, but her feet and legs are angled toward the door.

c. The tone and pitch of Amelia’s voice remain extremely consistent
with each of her answers, revealing almost no emotion.

d. When Rodrigo hands her documentation of the checks in question,
Amelia accepts the documents and looks closely at them for quite some time.

10. Although the vast majority of fraudsters are
first-time offenders, a handful of perpetrators are career criminals,
and a few of those are considered psychopaths. Some of the most
devastating frauds have been committed by individuals who fall into
this group. Which of the following is a trait commonly displayed by psychopaths?

a. Deep emotions.

b. Impulsivity.

c. An aversion to excitement or overstimulation.

d. Feigned modesty.

Answers

1. (b) In their article “Why Do CFOs Become
Involved in Material Accounting Manipulations?,” accounting professors
Mei Feng, Weili Ge, Shuqing Luo, and Terry Shevlin discuss their
research into the reasons CFOs fraudulently alter financial
statements. Their findings indicate that CFOs generally do not commit
such fraud for their own personal financial gain or to cover personal
transgressions; instead, their fraudulent acts typically are the
result of pressure from CEOs, who hold significant influence over
decisions related to the CFOs’ careers and compensations.

2. (c) Most fraudsters are trusted employees
who—due to the convergence of pressure, opportunity, and the ability
to rationalize a dishonest act—experience a lapse in their personal
ethical framework. Interestingly, the ethical lapses that underlie
fraud typically are exhibited in the form of thought patterns, or
thinking errors, that fall within several broad and recognizable
categories. One such category involves a perceived need for
instant gratification (for example, a desire for wealth
without the patience to earn it honestly). Melissa’s decision to
commit fraud rather than to wait seven years to finish her degree
demonstrates a thought pattern of instant gratification. Many
fraudsters display a similar desire for instant gratification;
consequently, CPAs need to watch for signs of this thought pattern or
circumstances that might lead to such an ethical lapse when
considering the presence or prevention of fraud.

3. (a) Milgram’s experiment involved the study’s
subject (dubbed the “teacher”) acting out a series of learning
exercises with another individual (dubbed the “learner”). The
researchers instructed the teacher to test the learner on some basic
concepts, and when the learner made a mistake, the teacher was told to
give the learner an electric shock, increasing the shocks in 15-volt
increments for each wrong answer. Unbeknownst to the teacher, the
shocks were fake, and the learner was an actor who simulated the
effects of receiving the shocks with increasingly loud cries of pain.
In response to the learner’s cries, many teachers demonstrated extreme
amounts of stress and expressed a desire to stop; nonetheless, when
ordered to continue with the experiment, most did. In fact, 65% of
participants administered the final 450-volt shock. In the preface to
his resulting book, Obedience to Authority: An Experimental
View, Milgram stated that “the essence of obedience consists in
the fact that a person comes to view himself as the instrument for
carrying out another person’s wishes, and he therefore no longer
regards himself as responsible for his actions.” Milgram’s findings
and summation underscore the need for CPAs to be mindful of the
culture set and messages sent by an organization’s leaders, as well as
the relative mindset of obedience displayed by key staff members, as
these factors play a critical role in determining the risk of
fraudulent actions by employees at all levels.

4. (c) The Association of Certified Fraud Examiners
(ACFE) has conducted research into the behavioral red flags displayed
by perpetrators during the time of their fraud schemes and has
identified notable trends. More than 80% of fraudsters exhibit
behavioral warning signs of their misdeeds, and, not surprisingly,
living beyond their means and experiencing financial difficulties
consistently are the most commonly observed behavioral red flags (see
Exhibit 1). In contrast, only about 5% to 10% of fraudsters studied
had previous legal problems, a finding that emphasizes the limited
effectiveness of relying on background checks as a fraud-prevention
measure. An analysis of the observed red flags based on the position
of the perpetrator reveals additional depth to the trends, including
the tendency of fraudsters at the managerial and executive levels to
be much more likely than staff-level perpetrators to have an unusually
close association with a vendor or customer, display control issues,
or exhibit a wheeler-dealer attitude.

5. (b) ACFE research has revealed some trends in
the statistical profile of individuals who engage in occupational
fraud. As noted in the ACFE’s 2012 Report to the Nations on
Occupational Fraud and Abuse, perpetrators are most likely to
be:

In a staff-level position.

Male.

Between the ages of 31 and 45.

Between one and five years of tenure at the victim organization.

The holder of an undergraduate degree.

Employed in the accounting, primary operations, or sales
departments.

First-time offenders.

Of course, CPAs should not take these findings to mean that all
occupational frauds are committed by individuals falling into these
categories or that all employees with these characteristics should be
suspected of engaging in fraud schemes. However, noting commonalities
among fraudsters can help CPAs dispel incorrect preconceptions about
typical fraud perpetrators and better assess risks of where potential
fraud might occur.

6. (c) Everyone lies. It’s part of being human. To
determine just how often we lie to each other, psychology professor
Robert Feldman observed strangers who had just met while they engaged
in small talk with the intention of becoming acquainted. The results
indicate that, on average, people tell three lies during a 10-minute
conversation, a finding Feldman has reached consistently in repeated
studies, as he notes in his book, The Liar in Your Life: The Way
to Truthful Relationships. The implications of this information
on a CPA’s work are notable. When much of one’s professional
responsibility involves relying on—or attesting to—the accuracy and
completeness of statements made by others, the results of three
undetected lies in each 10-minute conversation could be disastrous.
Building an awareness of not only the probability that other
individuals are lying, but also of the common signs of deception and
ways to ferret out dishonesty, is crucial to CPAs in reducing their
chances of being duped by clients or co-workers and missing important
warning signs of fraudulent conduct.

7.
(b) In their August 2006 Personality and Social
Psychology Review paper titled “Accuracy of Deception
Judgments,” Charles Bond Jr. and Bella DePaulo examine the combined
results of hundreds of studies in which individuals attempt to
determine whether statements are lies or truths. Their overall
observations reveal that the average person can correctly determine
whether a statement is truthful or deceptive 54% of the time—only
slightly better than the chance odds of 50/50. More specifically, the
individuals studied were able to correctly spot 47% of lies presented,
while they identified true statements with 61% accuracy. The
difference between these two rates is interesting and notable, as it
illustrates the notion that people are inherently biased toward
truth—that is, they tend to expect honesty from others and are more
likely to believe a lie is a true statement than to believe a truth is
deceptive. While this tendency is natural, it also clearly reinforces
the importance of a “trust-but-verify” approach and the need for
professional skepticism during CPAs’ professional engagements.

8. (d) Individuals attempting to conceal something
during a formal interview usually behave in certain ways that serve as
red flags of their dishonesty. For example, recurrent use of
oaths—statements such as “honestly,” “I swear,” or “to tell you the
truth”—in responding to questions might indicate that the interviewee
is attempting to add credibility to dishonest statements—particularly
if these are not phrases the individual frequently uses in normal
conversation. Other warning signs include a reluctance to terminate
the interview, as if the interviewee desires more time to convince the
interviewer of his or her innocence, and displaying a notably lenient
attitude toward hypothetical fraudsters (e.g., stating that someone
who might have committed fraud was likely just caught in a tough
situation or expressing that such individuals should not be punished).
Additionally, deceptive individuals are much less likely to voice
direct denials to an accusation, and their denials are more likely to
grow weaker with repeated accusations, whereas an honest individual’s
denials typically will grow stronger.

9. (a) For most people, lying causes stress and
discomfort, and these feelings are typically released in physical, yet
subconscious, ways. For example, if Amelia is attempting to deceive
Rodrigo by providing dishonest answers, her body might respond by
slowly moving into a “fleeing” position, in which her head and upper
body still face Rodrigo, but her legs and feet point toward the door
in an unconscious effort to escape the interview. Another possible
sign of deception is an individual’s leaning away from the interviewer
when serious questions are posed. Changes in speech patterns also
provide warning signs of dishonesty. If Amelia were to speed up or
slow down her speech, or if her voice were to become noticeably
higher, lower, louder, or softer as Rodrigo began asking about the
checks, it could indicate that the line of questioning is a sensitive
area for her and that her responses—or, more specifically, the
deceptions therein—are causing her stress. Similarly, most fraudsters
feel stressed when being handed evidence of their misdeeds and tend to
react by glancing at the document and quickly pushing it away or
handing it back to the interviewer. Knowing signs of deception to
watch for in conversations with others can assist CPAs in realizing
when they need additional verification of information from another
party and in identifying areas that might be subject to manipulation
and merit further exploration.

10. (b) Research conducted by Robert Hare, a
psychologist who specializes in psychopathy, indicates that
approximately 1% to 2% of people in the U.S. are psychopaths. However,
the percentage of fraudsters who are psychopaths is likely higher, as
many of the traits that underlie fraud, such as an ability to appear
charming and to manipulate others, are inherent in a psychopathic
personality. In their book, Snakes in Suits: When Psychopaths Go
to Work, Hare and Paul Babiak discuss the symptoms of
psychopathy and how they can be manifested in the corporate world. A
psychopath in the workplace could come across as: glib; superficial;
egocentric; grandiose; lacking remorse; lacking empathy; deceitful and
manipulative; seeking power; emotionally shallow; impulsive; poor at
controlling behavior; needing excitement; and lacking
responsibility.

Many of these traits can actually help an
individual advance through the corporate ranks. In the right light,
such individuals can appear charismatic, commanding, and bold, and
might even be upheld as natural leaders. However, these
characteristics can also greatly aid in committing and concealing
fraud. CPAs should be acutely aware of how people with such
characteristics can raise a risk of misconduct in an organization.

Scoring

If you answered nine or 10 questions correctly, congratulations.
Your solid knowledge about who commits fraud will assist you in
protecting organizations from the thieves within. Keep up the good work.

If you answered seven or eight questions correctly, you’re on the
right track. Continue to build on your knowledge of the
characteristics and behaviors of fraud perpetrators.

If you answered fewer than seven questions correctly, consider
strengthening your knowledge about fraud perpetrators and their risk
factors to help ensure that you have what it takes to keep assets and
resources protected from potential fraudsters.

Andi McNeal (amcneal@acfe.com) is director of research for the Association of Certified Fraud Examiners.

To comment on this article or to suggest an idea for another
article, contact Jeff Drew, senior editor, at jdrew@aicpa.org or 919-402-4056.

TAX NEWS

President Barack Obama signed legislation that retroactively extended more than 50 expired tax provisions for 2014, allowing taxpayers to take advantage of a host of tax incentives during this filing season.

A weekly snapshot of global accounting with news from the Journal of Accountancy and other leading accounting publications. It includes summaries of what matters to you, written by expert editors to save you time and keep you informed and prepared.